Rate cut may help households, but could increase inflation and pump up the property market, writes Warren Hogan
A rate cut next week might be the last for a while and the RBA needs to be careful not to stimulate the economy too much, writes economic adviser Warren Hogan.
Opinion
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A rate cut next week might be the last for a while
No one will be surprised if the cash rate comes down by another 25bp following next week’s monetary policy board meeting. If it happens, this third cut this year will take the cash rate from 3.85% to 3.6%.
The first cut in February came after some encouraging inflation numbers last summer. The 4.35% cash rate was reduced to 4.1%. That was a tweak after more than a year of interest rate stability, and interestingly, it was perfectly timed ahead of a federal election.
May was a different story.
Weak consumer data and the shock of Trump’s tariff announcement in April fundamentally changed the RBA’s risk perceptions. Concerns about persistent inflation were replaced with a genuine fear of a global economic downturn.
The RBA cut rates 25bp in May and signalled that they could do more. The financial markets agreed. A series of rate cuts that takes the cash rate to 3% by the end of this year has been factored into money market prices ever since.
Last week’s big fall in global oil prices as the Middle east settled down, and the better-than-expected monthly inflation numbers for May, appear to have made a rate cut next week a ‘slam dunk’ in most people minds.
The RBA signalled in their quarterly report in May that they are comfortable taking monetary policy to a ‘neutral setting’ over the months ahead.
That means a cash rate of 3.5% looks like a done deal. Some economists think neutral is more like 3% - implying a few more rate cuts later this year.
But what does neutral even mean?
Monetary policy is considered ‘tight’ or restrictive if the level of the interest rate is high enough to act as a drag on overall economic activity. Not a headwind for some businesses or households, the concept applies to the overall economy.
It is considered ‘loose’ or accommodative when the level of rates is providing a boost to economic activity. A ‘neutral’ interest rate is one that neither helps nor hinders the expansion of our economy.
Monetary policy that is set to a neutral stance should be considered a good thing. If the economy is in a position that the RBA feels that neutral policy is warranted it is probably because things are going well.
A ‘Goldilocks’ situation, not to hot, not too cold. Just right.
Unfortunately, the realities of our economy are not that simple.
For one, we don’t know what the neutral interest rate is (another thing for economists to disagree about).
Another factor is that consideration must be given for the recent changes to interest rates. A rate cut has an element of economic stimulus no matter what the level of interest rates while a rate hike has an element of restriction.
For home buyers, the lower mortgage rate will provide more borrowing power which they can use to secure a property with a higher bid. With dwellings in short supply across Australia this increased borrowing power has been and will likely continue to result in higher house prices.
Rising property prices have a positive financial impact on everyone who owns their own home, whether they have a mortgage or not. That is about two-thirds of Australian households.
The improvement in people’s wealth from rising house prices can be monetised through borrowing against the new higher value of the property or it may just give homeowners greater confidence to spend.
Whatever debates economists want to have about the neutral rate, monetary policy in Australia will be stimulatory if we get another rate cut next week.
We are seeing it in the property market where prices are now rising across the country. Property prices are a record high, as is the equity market. Household sector net worth is an unbelievable $17 trillion.
Property value underpins this. The total value of land Australian households own is estimated to be worth $8.5 trillion by the Australian Bureau of Statistics, up 70% since 2019 and 12 times national income. National income has increased by less than half this amount over the past 6 years.
The RBA needs to be careful not to stimulate the economy too much.
The economy is creating jobs, unemployment is low, and inflation is still lurking.
Consumer inflation may have come down over the last year but cost pressures in the economy have not disappeared. Businesses will eventually need to pass on these costs if they are to remain profitable. Inflation would stop falling and could easily start rising again.
Pay attention to what the Reserve Bank Governor says at the press conference next week.
Even if we see a rate cut, and it might even be an outsized 35bp reduction to get the cash rate right on ‘neutral’ at 3.5%, there is a good chance we won’t see many more.
Inflation coming down from around 4% to 3% over the past year has given the RBA scope to return monetary policy to a neutral setting. That is a good thing.
But the case to take rates lower will not rest on better than expected inflation results. It will happen if the economy turns out to be weak, something few of us want to see.
Warren Hogan is economic advisor at Judo Bank
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